Monday, 8 October 2007

Don't worry, back to normal in 4Q07

This seems to be the line being put forward by some major financial institutions. Yes we are going to take a hit in the 3rd quarter but once that is out of way it's back normal. After announcing a 60% decline in 3Q07 earnings last Monday, Chuck Prince, CEO of Citigroup (C) said he expects:

"a return to a normal earnings environment in the fourth quarter."

Thank God for that, back to normal - whatever that means. I wonder if it will be like Washington Mutual's (WM) new level of normalcy?

Merrill Lynch (MER) was much less sanguine after it's 3Q07 earnings pre-announcement which included $5.5 billion of write-downs. CEO Stan O'Neal noted that Merrill sees evidence of long-term growth in its businesses but that fourth-quarter revenue will be difficult to predict.

The meat of that comment is in what it doesn't say but you can take a stab at what it means. In the medium term Merrills will struggle to post earnings growth of any sort. MER along with many other financials are going to post 3Q07 earnings declines however this will not be a one-off. Those quarter over quarter earnings declines will turn into year over year earnings declines as the credit market problems work themselves out.

Did anyone expect homebuilders to take just one quarter of bad news given what's happened to housing? The big financials have been gorging themselves in an environment of easy credit for years that has produced fat profits. Now that things have got a little less easier they will forced on an earnings diet. It is only natural at this point in the credit cycle.

Wall Street has been clinging to the hope that this is a short-term phenomenon. They will end up disappointed. Punk Zeigel analyst Dick Bove is one analyst that has not been under any illusions:

"This is a multi-year problem, and the market, which has become very enthusiastic about these stocks, doesn't have a clue as to how deep the problems are,".... "The write offs they are taking are the beginning of a process that will take at least a couple of years to work out. This is simply not a one-shot development."

Spot on dicky-boy.